IBC process: In 2018, Centre must plug all loopholes to keep dodgy promoters out – The Financial Express–02.01.2018

IBC process: In 2018, Centre must plug all loopholes to keep dodgy promoters out

No year in recent times has been as eventful for corporate India as 2017 was. It was the first time ever that promoters that owed banks huge sums looked like they may have to give up the businesses they had built, and also perhaps the first time ever that they were unable to use any political connections to get the better of the banks. Former Reserve Bank of India (RBI) Governor Raghuram Rajan had said, in one of his speeches, that many of the country’s businessmen were free-loaders; the sanctity of the debt contract had been continuously eroded in recent years in India, Rajan said, not by the small borrower but by the large borrower. He observed how, in much of the globe, when a large borrower defaults he is contrite and desperate to show that the lender should continue to trust him with the management of the enterprise.

In India, it was an altogether different environment in which too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. This was possible because, till 2017, the legal system was skewed heavily in favour of borrowers who used every loophole to get away with not paying up, leaving banks vulnerable to defaults and haircuts. But, 2017 saw a bold and determined government willing to strengthen the Insolvency and Bankruptcy Code (IBC) to make sure errant promoters weren’t able to get back into the saddle.

Had the same promoter who was unable to service his loans been handed back his company with a substantial chunk of the debt written off, it would have made a mockery of the system and created a moral hazard. The IBC legislation had come into effect in 2016, but it was only in mid-2017 that RBI decided banks must make use of it and asked them to initiate action against a dozen big defaulters. For their part, banks had been hesitant—and justifiably so—to put up assets for sale fearing they might be accused of taking big haircuts.

To be sure, the law is yet to be tested and some promoters could still get away by not giving up their companies; there could be loopholes that they will exploit and once can already see differences of opinion between different benches of the NCLT (National Company Law Tribunal). Also, even if the companies or assets are sold off, it is unlikely banks are going to get more than 50-60% of their money back, and that’s an optimistic assumption. Some of the early bids reflect even bigger haircuts.

While it might seem harsh, because a lot of taxpayer money is involved, banks should take the haircuts and move on. There is no doubt that most of the promoters, who owe banks tens of thousands of crores of rupees, are wilful defaulters—they could have paid at least some of the amount, but didn’t.

There is, of course, no doubt that the banks were also to blame. They failed to assess the credit risks related to the projects, their grasp of economic and business cycles was clearly very poor, their assessment of the promoters also dismal.

What is unpardonable, however, is that they failed to ensure they had adequate collateral to back the loans. Even if the RBI guidelines allowed them to lend a certain share of their portfolio to a single company or a group of companies, they could, and should, have set themselves prudential limits and lent within those. But going by the quantum of loans that some companies were able to access, it is evident that the banks’ judgement was poor.
Also, while there were, and still are, bankers who are able to handle the pressure from politicians, it would be naive to think some bankers didn’t feather their nests and that they didn’t play along with the politicians.

But, all that is water under the bridge. What we need to ensure now is that erring promoters don’t get their companies back. The cost to the economy—will be high—lakhs of crores perhaps. But creating a moral hazard will be even costlier because businessmen will continue to take banks for a ride. If even one promoter—especially a big one—is handed back its company after the banks have taken a big haircut, it will set a precedent where others will flock to the NCLT to get themselves a similar deal.

So far, the government has shown it is committed to cleaning up the system—the kind of commitment that no other government has shown. Hopefully, it will be willing to tighten the legislation, if needed, to plug any loopholes. If even half a dozen businesses find new promoters, it would have opened up a new chapter in corporate history. One in which there would be a big lesson for promoters: it is not their divine right to borrow and not to return.

via IBC process: In 2018, Centre must plug all loopholes to keep dodgy promoters out – The Financial Express

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